Opportunities abound in emerging markets local debt ETFs

Jan 18th, 2013 | By | Category: Fixed Income

All the talk lately has been about whether we’re nearing the end of the bond bull market. However, Fran Rodilosso, a fixed income portfolio manager at Market Vectors ETFs, reckons that while investors need to accept that many traditional fixed income investments are unlikely to deliver the same types of returns as in 2012, there are still great opportunities to find if investors look in the right places.

Opportunities abound in emerging markets local debt ETFs

Fran Rodilosso, fixed income manager at Market Vectors ETFs.

Emerging markets local debt is one of these places, according to Rodilosso.

“I believe the time may be right to consider emerging markets destinations that offer more attractive yields on top of currency and credit fundamentals that appear to me to be on much more solid footing than the US dollar, euro or yen investments,” he said.

He added: “Interest rates in emerging markets countries are considerably higher than those in the developed world, despite emerging markets’ significantly lower debt-to-GDP ratios and fiscal deficits. The vast majority of emerging markets economies are growing faster than the US and I see an asset class that still can deliver incremental yield as well as diversify away from the US dollar.”

The emerging markets specialist also noted that currency movements can and have played a large role in the returns on emerging markets local currency bond investments. This is a positive part of the value proposition. “Emerging markets currencies are not undergoing the same monetary experiment that could lead to a debasement of the world’s reserve currencies”, argued Rodilosso.

Opportunities in emerging market debt have been buoyed lately by an expansion of the investable universe, which continues to grow as frontier markets develop into fully-fledged emerging markets with gradually more sophisticated debt markets. An example of this is the recent inclusion of two new countries in the JP Morgan GBI-EMG Core Index, the underlying benchmark of Rodilosso’s fund, the Market Vectors Emerging Markets Local Currency Bond ETF (EMLC). This JP Morgan index added Nigeria in late 2012 and is scheduled to add Romania from 1 March. This increase in investable opportunities provides a greater ability to diversify.

Despite the strong fundamentals and increased opportunities, the sector remains largely unexplored by mainstream investors. According to Rodilosso, “It is still my belief that global asset managers remain under-allocated when it comes to local currency emerging markets debt. Perhaps this is due to some investors’ tendencies to associate emerging markets in general with past boom/bust cycles. Add to that the fact that the relative strength of emerging markets may in itself be something that many investors are finding difficult to digest, let alone believe in enough to allocate significant capital, and that may very well be why we’re seeing value remaining in these markets.”

Investors looking to invest in this sector have a range of possible exchange-traded funds to choose from. In addition to the Market Vectors ETF highlighted above, US-based investors could consider the WisdomTree Emerging Markets Local Debt (ELD), the iShares Emerging Markets Local Currency Bond ETF (LEMB) and the SPDR Barclays Emerging Markets Local Bond ETF (EBND), all listed on the NYSE Arca.

UK and European investors also have multiple funds to consider. The space includes ETFs from Pimco/Source, iShares and SPDR, listed across a range of European exchanges (including the London Stock Exchange):

Pimco EM Advantage Local Bond Index Source ETF (EMLB)
Managed by Pimco in collaboration with ETF specialist Source, the fund offers high quality diversified exposure to countries driving emerging markets growth. Unlike traditional market-capitalisation-weighted indices, which reflect past patterns of debt issuance, the fund’s underlying index is weighted by GDP. This accentuates exposure to China and India and emphasises growing economies with strong fundamentals where there may be new opportunities. TER 0.60%.

iShares Barclays Capital Emerging Market Local Govt Bond ETF (SEML)
Tracks the Barclays Capital Emerging Markets Local Currency Core Government Index. This index offers exposure to emerging markets government debt from eight countries in local currency. Mexico, Poland and South Africa form the largest weights, comprising a combined 52%. The index includes certain maturity and minimum issuance size provisions to ensure liquidity. TER 0.50%.

SPDR Barclays Capital Emerging Markets Local Bond ETF (EMDL)
Tracks the Barclays Capital Emerging Markets Local Currency Liquid Government Index, a country-constrained index designed to provide a broad measure of the performance of liquid local currency emerging markets debt. The index limits country exposure to a maximum of 10% and, to be included, securities must have an amount outstanding of at least $1 billion equivalent. The country cap increases diversification. The top three weights are Brazil, South Korea and Mexico, which together comprise 30%. TER 0.55%.

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